The Birth of Passive Investing

This story begins in the post-war American economic boom of the 1950s. Mutual funds had already become mainstream in the US and were growing at an exceptional pace - returns attracted investments

All funds were “active” at that point - the fund had a defined objective to beat a particular index, and a fund manager (with a team of analysts) attempted to do so by handpicking various stocks & securities.

The booming stock market naturally sparked a lot of research in this domain, and academics studying the markets had started making some key findings. In 1952, Harry Markowitz’s “Modern Portfolio Theory” introduced the idea of risk-adjusted returns & argued that people with similar risk-profiles should hold the same diversified portfolio.

Then Eugene Fama’s Efficient Market Hypothesis (EMH) in the 1960s argued that earning excess returns or outperforming the market isn’t possible in the long-run, effectively since no one consistently has an information advantage.

EMH stated that markets are efficient to various degrees (weak, semi-strong, or strong), and stock prices reflected available information/news accordingly - the more efficient the market, and the less the information advantage. Both Markowitz & Fama later won Nobel Prizes for their efforts.

In 1972, Princeton University’s Burton Malkiel published his book “A Random Walk Down Wall Street”, in which he proposed that historical prices have no predictive power. And that investors are “better off buying and holding a diversified portfolio rather than trying to beat the market by purchasing individual stocks or actively managed mutual funds.”

“What we need is a no-load, minimum management-fee mutual fund that simply buys the hundreds of stocks making up the broad stock-market averages and does no trading from security to security in an attempt to catch the winners. Whenever below-average performance on the part of any mutual fund is noticed, fund spokesmen are quick to point out ‘You can’t buy the averages.’ It’s time the public could.”

These various academic findings, combined with the stock market crash of 1973, inspired Jack Bogle to establish The Vanguard Group in 1975. Jack was already a strong believer in passive investing, having studied & written a thesis on the mutual fund industry as an economics student at Princeton University

Vanguard soon launched the world’s first passive index fund called the First Index Investment Trust (now called the Vanguard 500 Index Fund) in 1976. Bogle’s fund wasn’t an immediate success, even being called un-American (for advocating average index returns) and being referred to as “Bogle’s folly”. But Jack Bogle persevered with his belief - and the rest is history.

Happy investing!

PS: India got its first passive investing options with the launch of the the IDBI Index INit’ 99 Fund in July 1999, shortly followed by the UTI Nifty Index Fund.